by M. Bradford Bedingfield

Legal Analysis

In December 2017, Congress changed the tax laws in a number of ways that affect incentives for individuals and businesses to make charitable contributions. Pub. L. 115-97 (Dec. 22, 2017) (Tax Cuts and Jobs Act of 2017) (“Act”). A variety of studies published since the new law was enacted predict an overall drop in 2018 charitable giving of as much as $22 billion (down about 5 percent from 2017 levels), and reports from the first two quarters of 2018 do appear to show a significant drop in charitable giving compared to 2017. While many attribute this drop to the Act, opinions differ on whether the changes in legal tax incentives are truly driving, or will drive, changes in charitable giving patterns. So what incentives changed beginning 2018, and how might those changes affect decisions whether and when to give to charity?

Changes in Tax Incentives

The Act increases certain incentives for charitable giving, and decreases others. However, all of the changes described below – other than the reduction in the corporate income tax rate – are temporary, and, barring further action from Congress, will expire at the end of 2025.[1]

Decreased Incentives

Standard Deduction. Most accounts of the impact of the Act focus on the increase in the standard deduction – from $6,300 to $12,000 for single filers and $12,600 to $24,000 for married and joint filers – which, along with the elimination or diminution of many itemized deductions, will convert many taxpayers from itemizers (those who itemize their deductions, and forego the standard deduction) to non-itemizers (those who instead claim the standard deduction, foregoing the ability to take itemized deductions). This change matters because the income tax charitable deduction is an itemized deduction, and therefore provides no tax benefit whatsoever to those who claim the standard deduction. Because each taxpayer chooses either to claim the standard deduction or to itemize, those who claim the standard deduction get no tax benefit from charitable contributions. Studies have estimated that more than 20 million taxpayers will convert from itemized to non-itemized filers this year as a result of the Act.

While the increase in the standard deduction clearly will change tax incentives for charitable giving, it is unclear to what extent that change will affect actual charitable giving. Many taxpayers make charitable gifts regardless of whether they will receive a tax benefit, and it is unclear the extent to which the value of that deduction actually encourages or discourages people from supporting causes that are dear to them. The effect of this change may also vary dramatically depending on the state in which a person resides. Taxpayers in states like Massachusetts are likely to have other significant itemized deductions, such as state and local taxes (despite the new $10,000 cap on those deductions) and mortgage interest (despite new limitations on deductibility of interest from certain home equity loans), meaning that they are more likely to remain as itemizers..

Furthermore, a strategy known as “bunching” can provide a work-around for the impact of the increase in the standard deduction on charitable tax incentives. Imagine that a single taxpayer gives $10,000 to charity per year and has no other itemized deductions. That $10,000 per year provides no tax benefit, as the donor is better off just taking the $12,000 standard deduction instead. But if the donor instead gives $50,000 once every five years (and nothing in other years), the donor can file as an itemizer in the “on” year (claiming a $50,000 itemized deduction), and as a non-itemizer in the “off” years (claiming the $12,000 standard deduction in each of those years). While this “bunching” strategy will provide some incremental tax benefit for those who otherwise would fall below the standard deduction threshold, it will also create a certain “lumpiness” in charitable giving patterns, and the lumpiness is likely to be back-loaded if donors, choosing to wait to see more precisely how the Act’s changes will affect their personal returns, give their $50,000 in later years rather than in the first year after the new changes.

Lower Taxes. Most taxpayers will find that they are paying taxes at a lower aggregate federal tax rate than before. This reduction in tax rates generally makes the income tax charitable deduction less valuable – because there is less tax liability to offset – even for individuals who itemize their deductions. (It also makes the charitable deduction less valuable for corporations, which now pay income tax at 21%, reduced from up to 39% before the Act). Whether, and how much, this decrease in the “value” of the tax deduction will affect charitable giving is debatable. In fact, some tout this as a change that may spur an increase in charitable giving, to the extent that lower taxes may increase cash available for charitable giving.

Estate Taxes. Federal estate taxes have been virtually eliminated for all but a very small number of taxpayers, as the federal estate tax exemption amount has increased to over $11 million per person (or over $22 million per married couple). Many fear that this will likewise reduce estate tax incentives to leave property to charity. However, the extent to which changes in the estate tax will affect the disposition of donors’ assets on death is likewise open to debate. The fact that donors are paying less in estate taxes might in fact increase charitable bequests, especially where donors (for non-tax reasons) choose to leave the residue of their estates to charity. Furthermore, because many states continue to have their own estate or inheritance taxes (especially in New England, the northern Midwest states, and the Pacific Northwest), donors in those states are less likely to change estate plans already optimized to minimize state estate taxes, many of which include charitable gifts as part of that optimization.

Ticket Rights. One minor decrease in tax incentives (although a significant one for many college football fans) is that Congress has eliminated the partial charitable deduction previously available for gifts to colleges and universities in exchange for priority rights to buy season tickets. In anticipation of this change, many colleges encouraged ticket holders to “pre-fund” their ticket-related contributions at the end of 2017. Otherwise, it is unlikely that this change will have a significant impact on charitable giving as a whole – as a graduate of a large, Southern state university, I am quite certain that, for most college sports fans, the incentives of securing priority season ticket rights far outweigh any reduced tax incentives.

Increased Incentives

While the general consensus is that the net effect on tax incentives for charitable giving is negative, the Act provided some minor boosts to charitable tax incentives.

Elimination of Pease Limitations. Prior to the Act, the so-called “Pease” limitations reduced certain itemized deductions, including certain charitable gifts, for high-income taxpayers, and thus potentially reduced the tax effectiveness of certain charitable gifts for those taxpayers. The Pease limitations have been suspended under the Act, which may provide a modest boost in tax incentives. On the other hand, it was never clear how much of an effect the Pease limitations actually had on charitable giving patterns, and so the effect of this change is likewise uncertain.

Increased AGI Limit for Cash Gifts. The primary “boost” to tax incentives for charitable giving relates to the percentage of a donor’s adjusted gross income (AGI) that may be deducted each year. Previously, donors could deduct up to 50% of their AGI for cash gifts to public charities (non-cash gifts, and gifts to so-called “private foundations,” are subject to less favorable AGI limits). Gifts in excess of this AGI limit are not deductible in the year of the gift, but may be deducted in future years, for up to five years.

The Act increased the AGI limit for cash gifts to public charities from 50% to 60%, potentially allowing certain donors to enjoy higher income tax deductions more quickly. However, because of the rather complicated way in which this increase was integrated into the existing tax code, the higher 60% AGI limit is available only when a donor is relying solely on gifts of cash to public charities, and not gifts of stock or other assets (or any gifts to private foundations), to make up that 60% amount. Many donors who give that much of their annual income are likely to have low-basis stock or other property, and the tax benefits of giving low-basis stock (namely, avoiding capital gains tax on the stock’s appreciation) to public charities significantly outweighs the benefit of this increased AGI limitation. In other words, on balance, most donors will still effectively be capped at the lower 50% of AGI limit. Although it is too early to know for certain, it seems likely that very few taxpayers will see any practical benefit from this increase.[2]

Good or Bad for Charitable Giving?

It is too early to know whether the Act will result in more or less charitable giving. Many popular strategies for saving taxes by making charitable gifts – for example, making gifts of appreciated property, or direct charitable IRA rollovers – remain effectively unchanged. For many taxpayers, the effects of the Act may not become evident until they see their first tax returns in 2019, and it may not be until then that they start to consider changing their charitable giving strategies. While it does appear that giving is down in 2018 (compared to 2017), this could be attributable to a number of things. For example, 2017 was a record year for charitable giving, in part because many tax advisors urged donors to make large charitable gifts at the end of 2017, at least in part to offset the higher 2017 tax rates. A corresponding drop in charitable giving in early 2018 might be a natural consequence of the fact that many taxpayers effectively pre-funded their anticipated 2018 contributions at the end of 2017. Other taxpayers may be temporarily holding off on giving in anticipation of “bunching” contributions in later years, or may otherwise be delaying the timing of their gifts, even if they intend to maintain past levels of giving in the aggregate.

At the end of the day, it is likely that only a particular subset of donors who will be significantly affected by these changed tax incentives. Donors who were non-itemizers before these changes are likely to remain so, and will see no meaningful change in tax incentives for charitable giving. Conversely, donors who previously were itemizers and, because of significant other itemized deductions, will remain so, still have plenty of incentives to find tax-efficient ways to reduce the burden of income or estate taxes by making charitable gifts. Anecdotal discussions with charitable giving and estate planning professionals indicate no significant shifts in donor interest in long-term charitable giving, including planned giving, among filers already likely to itemize. However, donors who are in that intermediate space between itemizing and not itemizing should take a close look at their particular tax profiles and consider “bunching” and other strategies to allow them to maximize the impact of their income tax charitable deductions over the long term under the Act.

[1] On September 28, 2018, the House of Representatives passed a series of bills, together dubbed “Tax Reform 2.0,” that would make these changes permanent, but as of this article, there appears to be no movement in the Senate in that regard.

[2]House Bill 6760, 115th Cong. (2017-2018) (Protecting Families and Small Business Tax Cuts Act of 2018), part of the “Tax Reform 2.0” initiative passed by the House on September 28, 2018, would expand the ability of taxpayers to take advantage of the higher AGI threshold – however, it is unclear whether the Senate intends to participate in “Tax Reform 2.0,” or whether this provision might make its way into some other bill with bicameral support.

Brad Bedingfield is counsel at Hemenway & Barnes LLP. Brad works extensively with nonprofit organizations, navigating tax, regulatory, and governance matters, guiding charities and other nonprofits through formation, reorganizations, mergers, affiliations, and dissolution, and advising on innovative use of charitable assets, including social impact bonds and other forms of impact investing.